A division is considering the acquisition of a new asset that will cost $2,570,0

Question

A division is considering the acquisition of a new asset that will cost $2,570,000 and have a cash flow of $740,000 per year for each of the four years of its life. Depreciation is computed on a straight-line basis with no salvage value. Ignore taxes.

Required:

a. & b. What is the ROI for each year of the asset's life if the division uses beginning-of-year asset balances and net book value for the computation? What is the residual income each year if the cost of capital is 8 percent? (Enter "ROI" answers as a percentage rounded to 1 decimal place (i.e., 32.1). Negative amounts should be indicated by a minus sign.)

Year Investment Base ROI Residual Income 1 $2,570,000 % 2 % 3 % 4 %

Explanation / Answer

Depreciation per year=2,570,000/4=$642,500

A. Return on investment:

B. Residual income:

$205,600

(2570000×8%)

$154,200

(1927500×8%)

$102,800

(1285000×8%)

$51,400

(642500×8%)

Year 1 year 2 year 3 year 4 Cost of new asset $2,570,000 $1,927,500 $1,285,000 $642,500 Cash flow (per year) $740,000 $740,000 $740,000 $740,000 Depreciation (per year) $642,500 $642,500 $642,500 642,500 Net income $97,500 $97,500 $97,500 $97,500 Return on investment (net income/cost of new asset) 3.8% 5.1% 7.6% 15.2%

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